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Chapter 14: Question 3Q (page 752)

Distinguish between the following interest rates for bonds payable:

(a)Yield rate

(b) Nominal Rate

(c) Stated rate

(d) Market rate

(e) Effective rate

Short Answer

Expert verified

The yield rate is the rate actually earned by the bondholders. The nominal rate is the rate fixed by the one who issues the bonds, usually expressed as a percentage on par value. The stated rate is the specified rate listed on the bond. The market rate is the current rate prevailing in the market depending on various factors. The effective rateis the true rate on the bond, which takes into account the effects of compounding.

Step by step solution

01

Meaning of Bonds Payable

Bonds payable is a liability that arises when a company issues bonds to generate cash. The company is a borrower, thus creating a liability. Bonds can be issued at par, discount, and at a premium. The pricing depends on the difference between its coupon rate and its market yield.

02

(a) Yield rate

  • Yield rate is the rate of return the bond generates. It can say what percent was made from an investment.
  • A company can use this rate to compare various projects or investments to decide which is most profitable.
  • Current Yield = Annual cash/ Bond price
03

(b) Nominal rate

  • Nominal rate is the rate bond issuer promises to pay the bond purchaser.
  • The rate is fixed, expressed as a percentage on par value, and is applied to the lifetime of the bond.
  • It is the actual interest rate stated without considering the effect of compounding.
  • Nominal rate = Annual Interest payment/ Face value
04

(c) Stated rate

  • Stated rate is the actual rate listed on the bond
  • It is the actual amount of interest paid by the bond issuer, similar to the nominal rate.
  • Example, if an issuer pays $60 on a bond with the face value of $1000, then the stated interest rate is 6%.
  • Stated rate = Bond payment/ Face value
05

(d) Market rate

  • Market rate is the prevailing rate offered on cash deposits.
  • It is determined by the current rate compared to the rate specified in the bond.
  • It considers two things: The present value of the bond`s face value & Present value of the bond`s interest payments.
  • This rate is driven by many factors such as the size and duration of deposits, the flow of funds in & out of the country, etc.
  • Market rate = Bond`s face value * Bond`s price quote
06

(e) Effective rate

  • Effective rate is the rate that will discount both the bond`s future. interest payments and the bond`s maturity value to a present value that is equal to the bond`s current market value.
  • It is similar to market and yield rate, but it takes into account the effects of compounding.
  • The more frequent the compounding period, the higher the rate.
  • Effective rate = [ 1 + i/n ] n - 1

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Most popular questions from this chapter

Question: (Debt Securities) Presented below is an amortization schedule related to Spangler Company鈥檚 5-year, \(100,000

bond with a 7% interest rate and a 5% yield, purchased on December 31, 2015, for \)108,660.

Cash Interest Bond Premium Carrying Amount

Date Received Revenue Amortization of Bonds

12/31/15 \(108,660

12/31/16 \)7,000 \(5,433 \)1,567 107,093

12/31/17 7,000 5,354 1,646 105,447

12/31/18 7,000 5,272 1,728 103,719

12/31/19 7,000 5,186 1,814 101,905

12/31/20 7,000 5,095 1,905 100,000

The following schedule presents a comparison of the amortized cost and fair value of the bonds at year-end.

12/31/16 12/31/17 12/31/18 12/31/19 12/31/20

Amortized cost \(107,093 \)105,447 \(103,719 \)101,905 $100,000

Fair value 106,500 107,500 105,650 103,000 100,000

Instructions

(a) Prepare the journal entry to record the purchase of these bonds on December 31, 2015, assuming the bonds are classified

as held-to-maturity securities.

(b) Prepare the journal entry(ies) related to the held-to-maturity bonds for 2016.

(c) Prepare the journal entry(ies) related to the held-to-maturity bonds for 2018.

(d) Prepare the journal entry(ies) to record the purchase of these bonds, assuming they are classified as available for-

sale.

(e) Prepare the journal entry(ies) related to the available-for-sale bonds for 2016.

(f) Prepare the journal entry(ies) related to the available-for-sale bonds for 2018.

On April 1, 2017, Seminole Company sold 15,000 of its 11%, 15-year, \(1,000 face value bonds at 97. Interest payment dates are April 1 and October 1, and the company uses the straight-line method of bond discount amortization. On March 1, 2018, Seminole took advantage of favorable prices of its stock to extinguish 6,000 of the bonds by issuing 200,000 shares of its \)10 par value common stock. At this time, the accrued interest was paid in cash. The company鈥檚 stock was selling for $31 per share on March 1, 2018.

Instructions

Prepare the journal entries needed on the books of Seminole Company to record the following.

(a) April 1, 2017: issuance of the bonds.

(b) October 1, 2017: payment of semi-annual interest.

(c) December 31, 2017: accrual of interest expense.

(d) March 1, 2018: extinguishment of 6,000 bonds. (No reversing entries made.)

Strickland Company owes \(200,000 plus \)18,000 of accrued interest to Moran State Bank. The debt is a 10-year, 10% note. During 2017, Strickland鈥檚 business deteriorated due to a faltering regional economy. On December 31, 2017, Moran State Bank agrees to accept an old machine and cancel the entire debt. The machine has a cost of \(390,000, accumulated depreciation of \)221,000, and a fair value of \(180,000.

Instructions

  1. Prepare journal entries for Strickland Company and Moran State Bank to record this debt settlement.
  2. How should Strickland report the gain or loss on the disposition of machine and on restructuring of debt in its 2017 income statement?
  3. Assume that, instead of transferring the machine, Strickland decides to grant 15,000 shares of its common stock (\)10 par) which has a fair value of $180,000 in full settlement of the loan obligation. If Moran State Bank treats Strickland鈥檚 stock as a trading investment, prepare the entries to record the transaction for both parties.

Question: What is the 鈥渃all鈥� feature of a bond issue? How does the call feature affect the amortization of bond premium or discount?

Devers Corporation issued $400,000 of 6% bonds on May 1, 2017. The bonds were dated January 1, 2017, and mature January 1, 2020, with interest payable July 1 and January 1. The bonds were issued at face value plus accrued interest. Prepare Devers鈥檚 journal entries for (a) the May 1 issuance, (b) the July 1 interest payment, and (c) the December 31 adjusting entry.
See all solutions

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